Yes, we recognize the irony that the brouhaha in the last 24 hours was precisely because the European Council's Conclusions last night did not include the word "intensify." For our readers that follow this saga, the last 24 hours generate much food for thought. The situation is more nuanced -- and more challenging -- than the headlines.
Here is where we stand as the day draws to a close in the United States.
As anticipated in last night's PolicyScope Risk Monitor, PM Johnson's statement today matched the EU hard line. Like the EU did yesterday, he has directed companies and citizens to prepare for a no-deal outcome at year-end.
Also as noted last night, Chancellor Merkel's statements must indeed have raised hackles at Downing Street. The most important quote from PM Johnson today responds indirectly to Chancellor Merkel and signals a hard line view in London:
"They (the EU) want the continued ability to control our legislative freedoms and fisheries in a way that is completely unacceptable for an independent country."
London also seems to be quite miffed and disappointed that the EU is not willing to give to the UK a trade deal on terms recently granted to a UK Commonwealth country (Canada).
With the proportion of action (the green line below) to rhetoric (the blue line below) increasing as we head into the weekend, PolicyScope Platform data confirms that additional inflection points remain on the horizon as another negotiation round commenced on Monday. Welcome to data-driven nowcasting for public policy risks....
Brexit dramas are far from over. Capital markets participants seeking certainty will be uncomfortable. Capital markets participants that maximize alpha from volatility will have a good run through the end of October.
Readers that are also PolicyScope Platform users may want to adjust their lexicon settings within Brexit and Banking to focus on "equivalence" and related terms in order to receive optimal performance through year-end with respect to Brexit-related risks.
Five Implications -- What Comes Next
1. Negotiations Will Continue: The talks scheduled for Monday in London will remain in place. Policymakers will continue to talk with each other by telephone. As noted yesterday, professional politicians hate to be the first to leave the negotiating table.
2. Last Chances for Compromise: Chancellor Merkel has already softened her public line, talking today about how "we must be prepared to make compromises. Dutch Prime Minister Rutte today attempted to smooth the waters, saying it was all just a "misunderstanding" to conclude that omitting the word "intensify" meant the EU was walking away from the negotiating table. Even President Macron signaled flexibility on fisheries by acknowledging that the status quo has to change.
This sets up a trade off. The EU compromises on fisheries. In exchange it will seek compromises from the UK regarding regulatory standards and subsidies policy (the "level playing field" issues).
Whether PM Johnson compromises on legislative autonomy is more a function of domestic politics and how much pressure UK corporates place on him in the next two weeks. Stay tuned.
3. Side Deals Possible: The vast majority of transition details technically have already been agreed during the negotiations. It is always possible that at the last minute these side-deals could be announced as a second-best alternative to minimize disruption. The move would constitute a concession by the EU (since they sought an all-or-nothing framework). But it would be a low key concession that would preserve the ability to maintain a high ground of depriving the UK of a broad free trade agreement.
4. The Nuclear Option -- Financial Services: No side deal has been negotiated regarding financial services. It is true that the balance of economics means the UK needs the EU more....but that is only with respect to goods. When it comes to services in general, and financial services in particular, the EU in the short-term still needs access to the City of London.
5. It Could Be Worse: A no-deal outcome will unquestionably be disruptive to cross-border goods trade between the EU and the UK. But as noted throughout this year to PolicyScope Risk Monitor readers, central banks and regulators have quietly put a few guardrails in place in the financial system, effectively extending the transition period through 2021. The OECD this week acknowledged that a small safety net exists:
"According to the European Central Bank and the European Commission, financial firms have started to take a number of necessary steps to prepare for an absence of agreement in the short-term...The UK has put in place a temporary permissioning regime for EU passporting firms and investment funds operating in the UK, which should help smooth the transition. A number of Memoranda of Understanding have also been signed to allow certain financial activities to continue and minimize disruptions in the event of a no-deal exit."
OECD Economic Surveys: United Kingdom (October 2020) p. 25
Yes, we did discover this report while using the PolicyScope Platform.
The red flags over the next few weeks that signal deteriorating discussions will all revolve around whether and how policymakers start making threats regarding the treatment of financial services firms. For more information on how the PolicyScope Platform and related analytical products can help you prepare for Brexit and other policy-related volatility challenges, please contact us today.